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Retirement Risk to the Unknown


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The scariest thing in the world is to run out of money. To enjoy your retirement years to the fullest — and to help prevent the possibility of outliving your financial resources — you will need to invest for income and growth throughout your retirement years. Social Security will probably make up a significant part of your retirement income.  However, many consumers don’t appreciate the risks they are facing in keeping other kinds of long-term retirement income.

The number of defined benefit plans has dramatically declined as 401(k) plans have taken the lead.  New mortality tables showing retirees are expected to live longer raised pension plans’ liabilities, forcing companies to set aside more money to meet them.  In a defined benefit plan, the employer has only an idea of what may be provided upon an employee’s retirement, based on years of service, age and income.

Low interest rates hurt pension funds two ways. First, they lower the returns on safe, fixed income investments like Treasury bonds. But they also drive up the current cost of providing a fixed monthly payment to retirees well into the future. That means companies have to set aside more money in their pension plans to cover the increased liability created by lower rates.

Defined contribution plans move more of the “risk of the unknown” to the employees’ plate. Mutual funds remain the investment of choice for many investors.  There is a greater recognition of the notion that stock investments are still risky even after long holding periods, and so efforts to ‘amortize the upside’ through higher spending may backfire on the retiree.

Workers with access to employer 401(k) plans must pick their own mutual funds or other investments, but typically it’s from a fairly narrow menu of perhaps a dozen pre-selected choices. Mutual funds come with significant risk as you will be subject to swings in the stock market.  Leaving money in a bank has (almost) zero risk but gives you a return of just 1%-2% at the moment.

Mutual funds are by their nature a collection of various individual stocks or bonds and other underlying investments. Essentially many mutual funds are invested in similar stocks and have the same investment objective. While you may have a number of different mutual funds however you certainly may not be diversified.

You should always understand all ways in which your financial advisor is compensated including compensation directly from mutual funds he or she might suggest.  Does the advisor receive an up-front load or sales charge or perhaps trailing compensation from the mutual funds in terms of 12b-1 fees?

Generally the funds are not the cheapest in terms of expenses and often include revenue sharing arrangements featuring the 12b-1 fees from the underlying mutual funds in addition to the wrap fee being charged by the brokerage firm.

Is it time for small investors to rediscover certificates of deposit? The idea is not as preposterously old fashioned as it seems.  Good financial advisers generally recommend keeping part of a portfolio in low-risk investments, and increasing that fraction as retirement age approaches. The idea is to cushion against crashing stock markets and keep cash handy, hopefully while still earning some income.

Stop worrying about the dreaded “running out of money”  This is the best time to buy income annuities, due to their combination of bond and mortality credits. For the retiree, those products are proportionately a much better deal than many other products.  This is likely a better strategy than going fully into drawdown and hoping to find a fund to replicate what an annuity will provide – you won’t.

There is nothing else that is going to provide you with the certainty and security of an annuity, so retirees should stick with annuities or, depending on the size of their pension pots, consider a combination of an annuity purchase to secure a basic guaranteed income for life and a portfolio of funds where they are prepared to take a greater level of risk.

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Monday, April 20th, 2015 Wealth Management Comments Off

Traveling to a Known Retirement Destination

One of the biggest challenges for retirees is managing withdrawals from their 401(k) retirement accounts.  Managing your withdrawals from your retirement accounts during retirement can be a complex task. Rather than simply admiring your 401(k) account balance, look at how that balance will turn into income in retirement. The employer 401(k) purpose is to provide a lifetime income. The whole idea is that all these savings are for the purpose of creating a paycheck in retirement.

Many Boomers may have had their last pay day or are getting closer to their last pay day and are realizing now, it’s up to me. How can I make this amount I’ve saved last 20 or 30 years or longer?  Once you reach age 70 ½ you don’t have a choice in terms of your required minimum distributions from any tax-deferred retirement accounts. Withdrawals from traditional IRA and 401(k) accounts are subject to income taxes on the full amount withdrawn.

Many Boomers have “rose colored glasses” with regard to the lifestyle they can realistically sustain during retirement.  Because there is no hard and fast rule, people often end up saving randomly and then hoping that it will be enough. This is a little like traveling without knowing where you’re going: Great if your only criteria is to get “somewhere,” but less than ideal if you have a particular destination in mind.

A popular rule of thumb says that you’ll need about 85 percent of your pre-retirement income during retirement in order to maintain your standard of living.  Using current interest rate and mortality assumptions, a $100,000 retirement plan account balance would produce lifetime income of about $450 a month for a 65-year-old couple—hardly enough for basic expenses and medical costs, let alone travel and leisure that those surveyed wish for.

People like the idea of controlling their own money. Individuals who turn to self-administering the amounts of income that they draw imagine that they can construct an investment portfolio that will give them a good living.  “Drawdown” plans provide flexibility for the saver but disconnects income from the return generated. Your withdrawal rate is especially important in the early years of your retirement, as it will have a lasting impact on how long your savings will last.  As is immediately obvious, there is therefore the possibility of simply running out of money.

Annuities are among the only financial products that can address what has become known as longevity risk, better known as outliving your money. Annuities can be structured to make set payments for your lifetime, with the insurance company taking on the risk of your living longer than your life expectancy in exchange for a potential profit if you die earlier than your life expectancy would predict.

There are over 15 different types of annuities — with each providing its own unique benefit proposition. If you effortlessly say that you do not like all annuities, then you should be able to easily say that you do not like all mutual funds or all bonds.  In general annuities are recognized for what they are: a guarantee of income for life regardless of life expectancy and the vagaries of the investment markets.

There are no-load annuities (aka: no commission) that provide full owner flexibility. In addition, annuity types like single-premium immediate annuities (SPIAs), deferred-income annuities (aka: longevity annuities), and fixed-rate annuities (MYGAs) have very low commissions paid to the agent. By the way, annuity commissions are built into the policy, so it is a net transaction to you.

Single-premium immediate annuities (SPIAs), deferred-income annuities (DIAs), fixed-rate annuities (MYGAs), and many other types have no annual fees.  Most Brokers make their living by charging YOU management fees based upon your portfolio’s total account value. To them, the word “withdrawals” is a dirty word.  So, as long as you stay with your broker YOU represent a lifetime income for him or her!

Annuities offer a number of guarantees and other features that can be well-suited to certain investors’ needs. For instance, guarantees of minimum income benefits or minimum withdrawal eligibility can give investors additional protection against market swings.

The features tied to life expectancy are almost impossible to duplicate with any other type of financial product, making annuities especially useful for those who want to eliminate that aspect of risk in their financial planning.

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Wednesday, April 15th, 2015 Wealth Management Comments Off

Managing Financial Destiny in Retirement

Our grandparents could count on living maybe 10 years after they retired. Our parents, maybe 20 years. Our boomer generation, though, has 30, and even 40 or more years to look forward to after we’ve retired! That 30 to 40 year span was an entire lifetime to people not so long ago!  Americans worry most about running out of money in retirement.  Individuals have an obligation to take control of their own financial destiny.

Take charge of your financial destiny by equipping yourself with the proper tools. Having a good Financial Aptitude will enable you to take personal responsibility for managing your finances, make investment decisions that match your short and long-term needs, select the right financial consultants and effectively plan for retirement.  When it comes to retirement planning by watching the news. Watch the 6:30 news program on public TV for information, and don’t watch the media hype for money information.  TV media hype is slanted, biased and mostly (just plain) ignorant.

The rule of thumb is you need about 15 times your annual salary at retirement to receive a pension of 80% of your final salary. It has been calculated that this should be adequate, after inflation, to maintain your standard of living after retirement.  Taking charge of your financial destiny is more suited to people that are going to have to eat into their capital to sustain their income in retirement. That is really, very broadly speaking, the retirees that have $200,000 to $1 million range of account balances.

Retirement accounts can be slaughtered by the financial markets.  Most U.S. workers will experience at least one disruption to their retirement savings during their lives, a shock that could set back their retirement considerably.  Some shocks are simply unavoidable, such as a stock market crash. For instance, since 1987 — less than 30 years — investors have endured four stock market crashes. If you expect to be alive for at least 10 years, it’s inevitable that more crashes are in your future.

With regard to your investments, you should only risk money you can afford to lose. For many people, that means having a portion of savings in investments that don’t lose too much value in a stock market crash, such as cash investments, bonds or stable value funds in 401(k) plans. For retirees, that means having enough guaranteed lifetime income to cover your basic living expenses, such as Social Security, pensions or an annuity — income that won’t decrease during an economic downturn.

Moving forward, retirees must have a stronghold on their financial future. The American financial system as we knew it, no longer exists.  In the old days, many Americans had a defined benefit (DB) pension that paid them a steady guaranteed income in retirement. But the pension landscape has shifted dramatically: now more than half of all US retirement assets are in self-directed defined contribution (DC) plans, such as 401(k)s and individual retirement accounts (IRAs) – and the figures are rising.

These DC plans and IRAs do offer millions the chance to build up and control their own nest eggs, but what they don’t offer is a guaranteed income in retirement. Instead, retirees must manage their nest eggs themselves and hope that their decisions – how much to save, where to invest, and how much to take out each year – and the ups and downs of the market, will permit their money to last as long as they do.

In the old days, DB pension income was partially related to how much the individual made before retirement: the higher the salary and the more years he or she worked, the higher the pension benefit. By contrast, with the DC or IRA, how much you have depends on how much you save and what investment returns you experience.

How can a couple know, many years in advance, what they might need to live on in retirement? What will be their basic food, shelter, clothing, health care, and transportation expenses, as well as the additional discretionary spending on travel, entertainment, etc.?

In the old DB pension system, the survivor would continue to receive an income for lifetime. Benefits are less certain in the DC and IRA world, since investments could return much less than the historical average during retirement, and/or at least one member of the couple could live far longer than average. It is possible to run out of money.

Women outlive men who are the same age by three to seven years on average, and as a result, make up the majority of older Americans.  Although women are expected to live longer, they tend to plan for about the same period of time as men. In fact, both groups often plan for too short a period, but the magnitude of the shortfall is greater for women.  Women need 20% more than men to retire because they are living approx. seven years longer than men.

When women retire, they are likely to be influenced in this decision by their spouses’ retirement, as well as caregiving needs of their spouses or other family members.  If a woman retires early for family reasons, she should be careful to insure that there will be adequate resources for her future. In the majority of couples, it is the wife who lives longer and is more likely to run out of money in retirement.

These challenges do present more opportunities to discuss strategies for ensuring a steady income stream throughout retirement.  The “lazy way” to lock in a lifetime income is using an index-linked fixed annuity whose gains are permanently retained even if the market nosedives or interest rates go to zero.

Once your guaranteed income is turned on, there are automatic lifetime income guarantees and peace of mind. You will not earn a bundle if the market soars but you won’t sing the blues if the market tail spins.  While this isn’t as exciting as trying to outguess the market or as near-sighted as keeping all your money liquid as if it will be needed tomorrow, it is a prudent and safe way to address your greatest fear of outliving your money.

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Thursday, April 9th, 2015 Wealth Management Comments Off

Stages of Retirement Process

So much retirement advice is geared towards seniors, yet it’s the middle-aged crowd that has the most to worry about when it comes to saving and investing.  Whether we choose to pay attention or not, American workers’ savings shortfall is a slow-moving tornado that’s going to hit many of us where we live.

An ongoing Gallup poll has shown that the 30 to 49 age group bears some of the nation’s greatest financial concerns.  People in their 30s and 40s associate saving money with sacrifice.  However, you need to plan as if you are going to live to be 90 and if you are under 40 you need to plan until age 100.

A person needs to look at the different stages of the retirement process – the accumulation phase, the investment phase and ultimately the income phase – for a more realistic approach to a healthy retirement lifetime. There’s been such tremendous focus once we shifted from the Defined Benefit world to the Defined Contribution (401k) world on the accumulation phase and the investment phase, and a failure to really recognize that we don’t have an appropriate income or distribution phase.

Back in the 1970s, the assumption was that most employers would provide traditional pensions that paid out income over a retiree’s lifetime, but most employers aren’t willing to do this anymore.  That leaves employees to rely on workplace 401(k) plans—originally meant as supplemental savings plans and not designed to provide lifetime income, aka an annuity.When the 401(k) came into existence, I don’t think anyone envisioned it morphing into a primary retirement vehicle for people.

What we’ve created over the last 40 years or so is an entire industry infrastructure around wealth accumulation instead of income. As an example, the minimum distribution requirements in tax laws encourage people to spend the money quickly instead of spending it in a way that will sustain them throughout retirement. Now that decades-long retirements are the norm, safe and even lifelong guaranteed income streams are only going to become more important for retirees of modest means.

Proper income diversification puts you in a better position to ride out those difficult times when they arise. It’s about maintaining a steady balance between return potential and risk in your different investments.  Today’s workers should be socking away more for retirement because the decks are stacked against them in ways that they weren’t 30 years ago.

If a person lives over 10 years in their retirement, they may be subject to a market correction – or a period of financial market downturn and recovery sometimes has taken years to achieve.  People with assets that are especially subject to market volatility may incur notable losses if their financial portfolio is not carefully diversified.  If the richest of the rich don’t know what’s going to happen with the market, why would average people think they can beat it?”

Conventional wisdom says people in their 30s and 40s should invest more heavily in equities than older planners, but given the market’s volatility – and stocks’ lack of principal protection – annuities, bonds and certain insurance policies may all be better bets.  A stock market correction is imminent, and if your portfolio is inflated, consider moving that money into a protected contract like an annuity.

Indexed universal and other cash-value life insurance policies are particularly popular right now, and for good reason. “They have the potential for growth with no risk, and they’re great for people in their 30s and 40s. They can’t lose money, and if something happens to them, their families will be taken care of. There’s no other financial vehicle in the world that can do that.

As any financial planner can attest, it isn’t only how much is saved but what is spent that determines whether a nest egg will last. Annuitizing at least part of your retirement nest egg makes sense.  Annuities aren’t an all or nothing proposition, the goal is to budget for retirement by dividing planned spending into essential and discretionary buckets, using annuities for essential needs.

Indeed, the annual withdrawal rate during retirement is the most important factor in minimizing the likelihood of outliving one’s money. Annuities help workers stretch out their retirement income over their lifetimes.  Knowing you’ve got a guaranteed income till you die is still a good thing that many people will value, so choose the certainty of an income for life, which only an annuity can provide.  That percentage, which differs for everyone, is based upon the amount socked away; age at the time of retirement; sources of guaranteed income, such as pension and Social Security; and annual living expenses.

When calculating a sustainable withdrawal rate, it is important to note that taxes and investment fees contribute greatly to nest egg erosion.  One of the keys to successful investing is keeping your investment expenses low.  Thus, higher costs equal a lower allowable spending rate.

An individual retirement arrangement, or IRA, is a special type of investment account designed to help people save for their retirement.  Money saved or invested in an independent retirement account (“IRA”) or 401k won’t disappear even in bankruptcy. Those funds are protected assets.

Account holders can contribute a certain amount of money per year ($5,500 in 2015) and are allowed an additional “catch-up” contribution of $1,000 per year if they’re over 50. Once the money is in the account, it can grow and compound on a tax-deferred basis, meaning you won’t have to pay taxes on your dividends each year or claim the capital gains in your IRA on your tax return.

You can invest your contributions in virtually any stock, bond, or mutual fund that trades on a major exchange, and some IRAs can even be used to invest in real estate or a business.

There are two main types of IRAs: traditional and Roth. The main difference between them boils down to how your contributions are taxed.  A traditional IRA allows qualified individuals to deduct their contributions on their current tax returns, up to the annual maximum contribution limit.

Whether you qualify for the tax deduction depends on your income level and whether you are eligible to participate in a retirement plan at work. Single taxpayers who are not eligible for a workplace retirement plan automatically qualify for a traditional IRA tax deduction, regardless of income. And, even if you have an employer-sponsored retirement plan, you can still qualify if your annual income is less than $61,000 ($98,000 if you’re married).

Married taxpayers, if neither spouse is eligible at work, are automatically qualified for the deduction. If one or both spouses are eligible for an employer’s plan, eligibility for a traditional IRA tax deduction is based on income.

Contributions to a Roth IRA are never tax deductible, but your qualified withdrawals are tax-free. And, since you’ve already paid taxes on your contributions, you are free to withdraw them (but not your investment gains) without penalty at any time.

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Friday, April 3rd, 2015 Wealth Management Comments Off

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